Financial Times

Central Bank calls for "adjustment" of fuel, electricity, transport prices
The Central Bank last week called for "adjustment" of administered prices of fuel, electricity and transport, enabling a reduction in borrowings of public corporations, which would help contain expansions in domestic credit which it said was partly fuelling inflation.

The bank said it would maintain policy interest rates at current levels and use "aggressive" daily open market operations to absorb excess liquidity in the market as high monetary and credit growth, contributed to inflationary pressure.

"The Monetary Board noted with caution that the high monetary and credit growth should be arrested to prevent further inflationary pressures being built up," the bank said in its monthly monetary policy review. "Accordingly, the daily OMO (open market operation) auctions will be used to absorb liquidity more actively."

The bank said monetary aggregates have been growing at a higher rate than the desired rate mainly due to the continuous expansion of credit to the private sector as well as to the public sector.

A major contributory factor for the public sector credit expansion has been the losses incurred by the Ceylon Electricity Board and the Ceylon Petroleum Corporation, which will continue to incur losses amounting to about Rs. 2.5 billion per month, unless corrective measures are taken, the bank said.

To prevent further inflationary pressures being built up, the daily OMO auctions will be used to absorb liquidity more actively. "Furthermore, the adjustment of administered prices of fuel, electricity and transport, enabling a reduction in the borrowings of public corporations, would also facilitate containing expansion in domestic credit," the bank statement said. "High priority should be given to strengthening the public enterprises reform programme. The Board also emphasised the necessity for expediting mobilisation of concessionary foreign assistance to cover tsunami related expenditure, as available domestic resources are limited."

The growth momentum of the economy is expected to continue in 2005 with a projected rate of around 5.5 percent, the Central Bank said. The negative impact of the tsunami disaster, particularly on the fisheries and tourism sectors, is likely to be temporary in view of the expected faster recovery. The services sector will continue to be the main driver of growth with significant contributions from telecommunications, port services and transport sectors. The industrial sector is projected to post a stronger performance.

"On account of the post-tsunami reconstruction activities, the construction sector is likely to expand at a faster rate," the bank said. "The agricultural sector is also envisaged to record a higher output, supported by favourable weather conditions, contributing to economic growth and reducing pressure on prices of domestically produced food items."

On the external front, the export growth is expected to continue in 2005, benefiting mainly from the continuation of high global economic growth and expected better access of Sri Lanka's apparel exports to the EU market, while the total value of imports is estimated to grow at a faster rate on account of imports for relief, rehabilitation and reconstruction.

The expected foreign assistance to finance tsunami-related expenditure and debt relief from donor countries would be sufficient to finance the additional import expenditure, and will improve the balance of payments position, while reducing the pressure on the exchange rate.

The rupee, which has appreciated against the major currencies so far in 2005, is expected to remain stable with the realization of the expected inflows, the bank said. Following the tsunami disaster, the fiscal deficit in 2005 is estimated to increase due to expenditure on relief, rehabilitation and reconstruction in the affected areas.

However, tsunami-related expenditure is expected to be financed entirely through concessionary foreign assistance to the government and to the private sector including NGOs. Debt relief is expected to lower the government financing requirement and enable the government to reduce existing debt to the banking system.

Inflation continued to rise in February 2005, partly due to high oil prices, the lagged effects of the drought conditions that prevailed in 2004, and increase in indirect taxes, the bank said. "The improvement in supply conditions due to favourable weather and recent appreciation in the exchange rate could reduce the pressure on prices. However, the impact of the recent appreciation of the rupee is yet to be reflected in the prices of imported goods."

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